I sold my VIX ETF yesterday. It was interesting to watch that index spike into the 20+ range from a low of 13, which is the level I had been looking for. But a valuable lesson came out of this play – for me – anyhow. The problem with VIX ETF’s is the contango effect. This is essentially the erosion of the ETF’s price over time as VIX contracts are rolled. Premiums for time and cost inefficiencies all eat into the value of this type of ETF. Thus, despite my rather accurate call in April on this blog to buy a VIX ETF as that index hit 13 (which I did), and sell if and when the index went over 18 (which I did intraday yesterday at VIX 21), I still lost about 8% on the trade.
Yes, I was aware of the contango effect when I bought the ETF. History suggests that the VIX tends to move violently up and down—thus, you can usually play this trade over a short period with little contango effect. if you observe the chart above- you will note that after my buy point in early April, the VIX index experienced an unusually long period of sideways movement. As noted on my original blogs, the VIX tends not to stand still for long. This time—it did stay still (relatively speaking). It went range bound between 13-15 for almost 3 months, before finally spiking over 20 yesterday. In the world of stock trading – where contango does not exist – waiting 3 months for a nice breakout like this one is fine. In the world of time erosion and cost inefficiencies such as with the VIX ETF’s rolling of futures contracts—a 3 month wait to be proven “right” is not an option. Conclusion: I was right that VIX levels of 13 were bottoming, and wrong on the time it would take that level to spike up to its topping zone.
Would I trade this ETF strategy again? Absolutely! Three month super-tight sideways movements are rare for the VIX—note the rarity of such events on the chart. Typically, you can get in and out on a spike within a month of trading the VIX. A short turnaround like that will normally not erode too much of an ETF through contango. While there is always the potential for another price-eroding low volatility period on my next VIX trade (which again would be executed anywhere near a VIX level of 12 or so) – the odds are usually good for a rapid and potentially profitable spike at that level.
For those interested, we continue to maintain a 6% weighting in inverse ETF’s, a 3% weighting in gold, and a 33% weighting in cash. The balance of our equity is largely low beta.